Last year was the worst one year performance of our Canadian dollar in our entire history. Obviously the massive slide in the price of oil from north of $100 a barrel to where it stands now in the $30 range has had a major impact on our currency. I am asked often by clients where I think the dollar goes from here.
Here are some highlights:
• US dollar cycle has been maturing, but based on long-term valuations and other fundamental factors, it may continue to strengthen
• Canadian dollar has undergone a prolonged period of weakness, but may weaken further as valuations have yet to reach extreme levels
• The Bank of Canada is in a position of strength relative to other major global central banks as it still has monetary policy options at its disposal. Should they use these monetary policy to lower rates, the Loonie will likely head lower.
• Oil prices have been the biggest driver of movements in CAD/USD exchange rate over the past 18 months, but correlations have been inconsistent over the longer-term. Said another way, even if oil does rebound, the Loonie could remain under pressure.
• Deteriorating canadian terms of trade have placed further downward pressure on the Loonie, although weak Loonie should benefit non-energy Canadian trade in medium-term.
• Weak Mexican peso has posed major challenge to competitiveness of Canadian exports: Mexico surpassed Canada as second largest source of US imports in 2009 and Canadian share of US imports has trended downward since late 1990’s.
Canadian dollar is likely not heading significantly higher anytime soon
I conclude that the Canadian dollar is undervalued, but not significantly so.
Historically the Loonie trades significantly higher than fair value for long periods of time, historically 5-7 years, and also trades significantly lower than fair value for the same length of time. We are less than one year into the Loonie trading below fair value. Therefore if history is any guide, we have 4-5 years to go before the dollar heads north of fair value. As a point of interest most economists agree that fair value of the Loonie is in the 80 cent range. It currently trades in the low 70’s. Let me point out that within prolonged periods of time where the Loonie trades below fair value, there is often short term spikes. Meaning, we could see short periods of time where the Loonie strengthens.
Maintain 20-30% of your investments in USD
For the above reasons we continue to have between 20-30% of portfolios invested in securities that trade in USD$. Most Canadians spend 20-30% of their money on goods imported from the US on an annual basis. Therefore, having 20-30% of their portfolio invested in US$ acts a hedge in case the Loonie weakens. Think of it this way, your annual trip to Florida and the price of your groceries may increase when the Loonie slides, but on the other side of the ledger, you profit from the weaker Loonie with your investments.